I am writing this on the way back from the World Urban Forum in Medellin. It was a terrific experience, bringing together thousands of urban leaders from across the globe. UN Habitat did a fantastic job of organizing, and the City really rolled out the red carpet.
I wanted to share some of the experience with members of this municipal finance practitioners' community. Two sessions stood out for me, because they were at the intersection of urban finance and urban law, which is a busy intersection these days!
The first session that excited me was a Wednesday dialogue on “Equity in Urban Law”, which was kicked off by WB General Counsel, Anne-Marie Leroy. UN Live United Nations Web TV - World Urban Forum 7, (5-11 April 2014, Medellin, Colombia) - Dialogue on Equity in Urban…
Anne Marie spoke on the relationshipo between law, equity and urban finance, making the point that cities require significant funds to deliver urban services. She pointed out the virtuous cycle of
investment: if funds are wisely invested, the urban economy and productivity grow, and this generates still more funding for investment. While many cities have obvious poverty and deprivation, cities are also where the highest personal and corporate incomes are generated, where valuable property and other forms of wealth are concentrated, and where most consumption occurs. These are the things that governments tax: incomes, wealth, and consumption. Tying together urban equity and finance, Anne-Marie
suggested some guiding principles:
- Encourage the rich and middle class to use public services. Their payments, and their political weight, are essential to building an infrastructure backbone that works for all citizens. When a city provides low quality services, this encourages the rich to opt out, to live in gated communities, and to arrange their own services and work-arounds. This imposes real costs on the rest of the city. Having all segments of society in the same pool increases the financial base and also the political weight of consumers.
- Price urban services fairly. It is not fair to expect city utility departments, or private utilities, to sell services at less than their cost of production. Where tariffs are unreasonably low, services are shoddy. And we know that when average tariffs are held below the cost of production, the greatest benefit goes to the biggest users. If cities price services fairly, and ask those who can, to pay the fair cost of decent services, then they will have a robust financial base.
Fair pricing does not mean that we ignore the poor – quite the contrary. An equitable city works to ensure that all residents share in urban benefits. If the poor cannot afford the fair price of
services, they should receive assistance. This can be in the form of cash grants, or in the form of discounted pricing based on poverty. South Africa’s great experiment with “free basic services” is one framework that offers real promise, even though its implementation is not fully realized.
- Spread the investment burden: Just as the operational cost of providing services must be reflected in fair pricing, so must the capital cost of creating infrastructure capacity. The high end
urban developments which our cities showcase must pay for the capacity they consume, if our urban systems are going to have the capacity they need to serve all citizens.
Land value capture techniques can ensure that as public investment increases the value of private property, a portion of that increase is captured to help pay for the public investment.
Land often becomes more valuable as a result of government action, which can be linked to a tax, fee or levy to capture a portion of the value created. these fees can be used directly, and
leveraged through borrowing, to provide the infrastructure that our cities need.
Another interesting panel was the dialogue on Thursday, on “Innovative Financing Mechanisms for Local Authorities." UN Live United Nations Web TV - World Urban Forum 7, (5-11 April 2014, Medellin, Colombia) - Dialogue on Innovative Fina…
I participated in this session, and invited the audience (more than 2000 people showed up to hear about urban finance) to think about financing as a two part exercise:
- First, the revenue challenge– where should the money for infrastructure investment come from? Local authorities, depending on their legal framework, may have a variety of revenue sources available, including local taxes, shared taxes, unconditional transfers, conditional transfers, and user charges.
- Second, the challenge of leveraging of these revenues, through borrowing, or other arrangements. Mechanisms to do this can include loans, bonds, financing leases, and public private partnership structures.
Conceptually, separating the revenue piece (funding) from leveraging techniques (financing) avoids confusion. Without revenues, there can be no borrowing, at least no responsible borrowing.
And, on both the revenue side and the leverage side, there are innovative approaches to explore. On the revenue side, these approaches take various forms. In Medellin, the city has a “plusvalias,” levy under which a property owner pays the city a share of the value realized, for example, when the city allows more intensive development. Separately, Medellin also uses a “valorization” levy, which resembles the UK betterment levy or the US special improvement district: property owners pay a contribution toward infrastructure that will benefit them specially.
Another important source of municipal revenues, which is not widely enough used, is the capital contribution charge, or development charge, under which the property owner desiring to connect to a water, sewer, or electric system, repays the capital cost a city has incurred to create e.g. raw water, treatment capacity, and distribution capacity. A related charge is the impact fee, which
municipalities can collect to offset the cost of off-site impacts from drainage. Increases in density affect urban transport, and require investments to improve city streets, mass transit, etc. Increases in impervious area increase drainage, and require investments for water retention facilities, storm drainage culverts, etc. Congestion charging or car tolls in urban areas are one specific kind of impact fee – where individuals choose to drive into town, they impose congestion and pollution on society. Charging for these impacts can be a way to fund infrastructure that helps mitigate congestion or fund mass transit alternatives to individual cars.
A final revenue source that deserves mention is the use of tax increment financing. Without changing the rate of taxation, the valuation of an area should increase with urban renewal . Any increase in tax revenues within a tax increment district, over the revenues in the base year, can be ring-fenced and used to pay for infrastructure to benefits the area. No new fees or taxes per se, just capturing a portion of the value created.
Finally, we should not forget the basics – both property taxes and business taxes are buoyant revenue sources that increase steadily with the growth of the urban economy, and are probably the most significant value capture mechanisms in cities around the world.
Since the theme of the World Urban Forum is equity, it is important to note that the virtue of systems like valorization, or capital contributions, or impact fees is that they align and assign costs in a manner that is consistent with their economic impact. This avoids the situation that currently exists many cities where taxpayers or consumers at large, whether national or local, subsidize the costs of private development for profit. If the cost of infrastructure investment for future connections is included in the tariffs of current customers, then all water users, rich and poor, are subsidizing future developers. In a growing city, monthly charges for water, sewer and electric can become significantly higher than necessary.
When it comes to leveraging, any of these revenue sources can be leveraged through borrowing. And there are many variants on leverage wuth new varieties always being invented. Social investment bonds, green bonds, innovation funds, and so forth. Investors have shifting preferences, but if a city has solid financials and good management, it can always find investors. From the point of view of the municipality, the key is not the specific flavor of the bond – it wants to get a good deal. Cities should offer a product that an investor wants, but it must make financial sense to the city as well.
Other panelists on the financing panel included the impressive Mayor of Mandaluyong City, Philippines, the founder of a MENA credit rating agency, local and national officials from the region, and Professor Larry Walters, of Brigham Young University.
One thing that excited me about this year’s World Urban Forum is that the development community is moving beyond the mere celebration of urbanism and its potential, and is beginng to focus on the nuts and bolts of making cities work better for everyone. That this involves both municipal finance and municipal law is very exciting for me!